A cautionary tale of debt relief

Many governments in the emerging world are facing a difficult conundrum: how to balance the near-term health risks of Covid-19 against the long-term impact of lost livelihoods.

Underdeveloped healthcare systems and fragile economies mean that many of these countries do not have the fiscal firepower to fight the disease or the economic downturn.

A suspension of debt payments will free up vital funds to fight the crisis and this looks increasingly likely after private and official creditors agreed to collaborate on a debt standstill beginning May 1. The Debt Service Suspension Initiative (DSSI) will apply to 77 countries, which have outstanding debt payments amounting to $140 billion.

But the process is complex and unless solutions are developed to guarantee debt sustainability and continued access to capital markets in the future, it could do more harm than good.

It requires significant collaboration between all stakeholders… to ensure that countries are not stigmatized for coming forward for relief 

It requires collaboration between all stakeholders – the Paris Club, G20, China, multilateral development banks, private creditors, ratings agencies and governments – to ensure that countries are not stigmatized for coming forward for relief.

This may require a fundamental shift in how ratings agencies view standstills. S&P Global says that while it will not treat nonpayment of official debt as a default, it may view such action on debt due to private creditors as credit negative or indeed a default. This could make financing a recovery in hard-hit countries extremely difficult.

These are extraordinary times. All over the world, people and companies are making use of government schemes offering mortgage holidays and repayment relief, and are not being penalized with lower credit scores. Why should it be any different for countries?

Virus-induced crunch

Of course there is a difference between countries that are facing a short-term virus-induced crunch and those who have, over several years, let their debt build to unsustainable levels. There is still a case for downgrading the latter, but a mechanism is needed to ensure that those facing short-term cash problems are not penalized.

However, we cannot get away from the fact that many countries already have a debt problem, which will be exacerbated by the current crisis. Total external debt in countries eligible for the DSSI has more than doubled since 2010 and now exceeds $750 billion.

Stakeholders such as the United Nations say that a debt standstill is only the beginning and that proper debt sustainability analysis will likely lead to follow-on relief and restructuring amounting to around $1 trillion.

What is crucial is that any debt relief is accompanied by proper oversight to ensure the same mistakes are not repeated. People whisper in development circles that the heavily indebted poor countries, or HIPC, initiative has proved a failure.

The onus will be on governments to deliver transparent reporting on use of proceeds and source of funds, and on the IMF, which has all the tools and access to data, to establish a new body to oversee it.